Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Wage Growth Is the ECB's Next Headache
Transcript
- Lucas: So the latest CPI print out of the eurozone had a headline number that looked almost cooperative, 2.4 percent, but underneath it, services inflation is still running at 3.9 percent. And that gap is really the story. Luna: Right, because services are the part of the basket that's most tied to domestic wages. And wages are the thing the ECB can actually influence. Lucas: Exactly. And the latest data we have from the first quarter shows negotiated wages across the eurozone up 4.5 percent year-over-year. That's down from the peak of 5.3 percent, but it's still way above the level that's consistent with the 2 percent inflation target. Luna: So the ECB is trying to bring inflation down, but every time workers get a pay raise, it kind of puts a floor under prices. Lucas: It's the classic wage-price spiral, but with a lag. The ECB's own projection is for wage growth to ease to 4.8 percent this year and then 3.5 percent next year. But the realized data keeps coming in a bit hotter than those forecasts, especially in Germany. Luna: What's going on in Germany specifically? I know they've got that tight labor market, but is it different from the rest of the bloc? Lucas: Germany's unemployment rate is at 3.1 percent, which is basically full employment. And they have these powerful industry-wide collective bargaining agreements. The metal and electrical workers, for instance, just negotiated a 5.2 percent increase. That's a benchmark that then gets copied across other sectors. Luna: So one big deal in one industry can set the tone for the whole economy. Lucas: It's a ripple effect. And it's not just Germany. The Netherlands, Spain, Italy, they're all seeing wage growth in the 4 to 5 percent range. The common thread is that labor markets are just tight almost everywhere. The eurozone unemployment rate hit a record low of 6.3 percent in June. Luna: That's remarkable given all the economic slowdown talk. Lucas: It is. And here's where it gets tricky for the ECB. They've paused rate cuts for now. The deposit rate has been sitting at 2.5 percent since April. But the market is pricing in a 25 basis point cut in September. The question is whether wage growth slows enough to justify it. Luna: So what would make them hold off? More sticky services inflation? Lucas: Right. If services inflation stays stuck above 3 percent, and wage growth doesn't decelerate, they can't cut. Because cutting rates would only stimulate demand and give businesses more room to pass on higher labor costs. Luna: It feels like a really delicate balancing act. Lucas: It is. And there's also a structural story here. Europe's population is aging, and that's putting long-term upward pressure on wages, especially in healthcare and care work. Those sectors are labor intensive and they're only going to grow. Luna: So even if the economy cools, wages might not fall back to the old normal. Lucas: Exactly. And that's why this episode is really about the question of whether the ECB can afford to cut rates into a wage environment that's still this hot. It's not just about the next data point, it's about the structural shift in the labor market. Luna: And that's a big deal for anyone with a mortgage or a savings account in Europe. Rate decisions affect all of us. Lucas: They do. And honestly, if walking through the economy with us has made something click for you, the smallest way to keep this show going is to buy us a coffee. It's buy me a coffee dot com slash fexingo. No pressure, just if it's worth a coffee to you. Luna: Yeah, we're a small team and listener support is literally what keeps this ad-free. Every bit helps. Lucas: So back to that wage question. One thing I find really interesting is how the ECB talks about this. They keep saying they're 'data dependent', but the data they're looking at is increasingly forward-looking. They're not just looking at current wage growth, they're looking at what it will be in 2027. Luna: So they're trying to see through the cycle? Lucas: Exactly. They want to know if this wage spike is temporary or if it's a new normal. And there are some signs it might be easing. Vacancy rates are starting to come off their highs, and a few of the big unions in Germany are accepting longer contract durations in exchange for smaller increases. Luna: That does sound like a cooling off. Lucas: But the actual data on negotiated wages hasn't turned yet. The first quarter was still 4.5 percent. And with the Paris Olympics this summer, the services sector is likely to see a bump in demand, which could keep prices elevated. Luna: So it's a coin flip for September. Lucas: I'd say the market is leaning slightly toward a cut, but it's not a slam dunk. The real wildcard is what happens with productivity. If wage growth is accompanied by strong productivity gains, then it doesn't necessarily feed through to inflation. But European productivity has been lagging. Luna: And that's the thing, right? Because if wages go up but productivity doesn't, businesses just pass on the cost. Lucas: That's the risk. And it's why the ECB is so focused on services inflation. It's the canary in the coal mine for that wage-price pass-through. Luna: So what would you be watching for in the next few weeks? Lucas: The second-quarter wage data comes out in September, right before the meeting. And also the eurozone PMI services index. If that stays above 50, the economy is still growing, and that gives the ECB more confidence that they can cut without reigniting inflation. Luna: It's a lot of moving parts. Lucas: It is. And that's why I think the most interesting angle here is the structural one. We're not just talking about a temporary blip in wages. We're talking about a fundamental shift in the balance of power between labor and capital in Europe. And that's going to shape the economy for the next decade. Luna: That's a big picture, but it's also really concrete for anyone who's got a job or runs a business. Lucas: Yeah. So, when the ECB does cut, and they probably will at some point, don't expect a rapid series of cuts. They're going to be cautious, they're going to be data dependent, and they're going to be watching every single wage agreement that comes out.